Question 1

Relative prices only change when demand and supply for individual goods shift outwards.

Accepted Answer

Relative prices can also change due to changes in inflation or changes in exchange rates.

Question 2

Under the absorption approach, if the economy is below full employment, then it is best to improve the trade balance by:

Accepted Answer

The absorption approach suggests that if the economy is not at full employment, increasing domestic production can lead to an improvement in the trade balance. Devaluation can make domestic goods cheaper for foreigners and increase demand for them, thus boosting exports and improving the trade balance. Therefore, increasing domestic production through devaluation is the best choice out of the given options to improve the trade balance under the absorption approach. Cutting government spending, household spending, or income can reduce aggregate demand and worsen the unemployment situation.

Question 3

Assume that U.S. imports are contracted in foreign currency and the U.S. exports are
contracted in domestic currency. If the dollar is devalued, then the balance of trade will become more negative.

Accepted Answer

A devalued dollar means that foreign currency can buy more dollars, which makes U.S. imports more expensive and U.S. exports cheaper. This leads to an increase in imports and a decrease in exports, resulting in a more negative balance of trade.

Question 4

Assume that the U.S. demand for imports is perfectly inelastic. If the dollar is devalued then the total import value in dollars) will:

Accepted Answer

When the U.S. dollar is devalued and demand for imports is perfectly inelastic, the quantity of imports does not change, but the price of imports in terms of dollars increases. Therefore, the total value of imports in dollars increases.

Question 5

A theory based on the relationship of domestic spending for domestic goods relative to domestic output is known as the elasticities approach.

Accepted Answer

The elasticities approach to the balance of payments focuses on the responsiveness of export and import volumes to changes in relative prices, and does not directly relate domestic spending for domestic goods to domestic output.

Question 6

Domestic currency devaluation always improves the balance of trade in the short run.

Accepted Answer

Devaluation can improve the balance of trade by making exports cheaper and imports more expensive, but its immediate effect may not always be positive due to factors like price elasticity of demand for exports and imports, and the time it takes for businesses and consumers to adjust to new prices.

Question 7

Assume that the supply of foreign production is perfectly inelastic. If the dollar is devalued then the total import value in dollars) will:

Accepted Answer

The answer of Assume that the supply of foreign production...

Question 8

One way absorption theory can be seen in practice is:

Accepted Answer

The answer of One way absorption theory can be seen...

Question 9

Assume that a country is at full employment and wants to improve its trade deficit by devaluing its currency. Using the absorption approach which of the following methods will improve the trade deficit?
I. Increase government spending
II. Increase consumption taxes
III. Increase income taxes

Accepted Answer

Increasing consumption and income taxes can reduce domestic absorption, leading to a decrease in imports and an improvement in the trade deficit.

Question 10

The responsiveness of quantity to changes in price refers to elasticity.

Accepted Answer

This statement is true. Elasticity measures the degree to which quantity demanded (or supplied) responds to changes in price.

Quiz 12: The Balance of Payments